Clergy IRS Dual Status Creates Tax Havoc
The IRS places unique and confusing rules on pastors and ministers by taxing clergy as IRS W-2 employees with dual status. This complicated arrangement must also balance with church regulations offering clergy various tax assistance and deduction options. The interpretation and reporting of this dual-status identity are often beyond the scope of most tax filers and many professional preparers.
Dual-status means ministers pay Social Security and Medicare taxes through the SECA system instead of the FICA system that most employees work under. Earnings cannot be subject to both systems, thus the dual status identification.
SECA, an acronym for the Self-Employment Contributions Act, is the system through which self-employed individuals pay Social Security and Medicare taxes. “Hey, Pastor Smith, you’re in business for yourself!”
FICA, an acronym for the Federal Insurance Contributions Act, is the system that MOST employees in the United States work under. If applicable, Social Security and Medicare taxes are deducted from wages. “Pastor Smith, you are an employee of Hilltop Church.”
Often making matters more difficult are part-time office help and church volunteers who “do bookkeeping.” Churches may even ask clergy how they want their checks handled. Very few clergy members are tax specialists, and most people don’t know that clergy compensation is dealt with differently than any other profession in the United States.
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Clergy IRS dual-status identification
The clergy generally performs ministerial services as an employee of the church, and must meet specific IRS criteria:
- Be licensed, ordained, or commissioned.
- Administer the sacraments of the church (weddings, funerals, baptisms, and communion, etc.).
- Be considered a religious leader by the church.
- Conduct religious worship.
- Have management responsibilities in the church.
For their services in the ministry, pastors generally receive a W-2. However, NO Social Security or Medicare taxes may ever be withheld for their ministerial services. Clergy members must pay Social Security and Medicare taxes by filing Form 1040 (Schedule SE), Self-Employment Tax. Pastors must also estimate their tax liability and send the IRS quarterly payments or risk facing nonpayment or underpayment penalties.
To repeat, dual-status means ministers pay their Social Security and Medicare taxes through the SECA system rather than the FICA system that most employees work under. Dual status requires clergy members to pay ALL of their Social Security and Medicare taxes.
Working within Clergy IRS dual-status rules
For members of the clergy, the W-2 reports all taxable compensation as wages. Also reported on the W-2 are designated parsonage or rental or housing allowance and a utilities allowance.
Generally speaking, the amount of the minister’s income that is subject to the self-employment tax includes the base salary, the housing allowance, or the fair rental value of church-provided housing. See publication 15-A, Employer’s Supplemental Tax Guide (PDF).
NOTE: Compensation ministers receive directly from members of the congregation (as well as non-congregation individuals) such as fees for performing marriages, baptisms, funerals, or other personal services, are generally considered self-employment income by the IRS. Both the salary received from the church and fees received from members of the congregation (and non-congregation fees) are generally subject to self-employment tax.
Love offerings, gifts, and the guest preacher
Many churches often on quarterly or specific holidays, take up a Love Offering for their pastor. Something extra. The IRS, however, counts this love as wages, taxable as such.
On Pastor Smith’s birthday, kindly Mr. and Mrs. Wilson include a check for $25 in the card with a note encouraging their pastor to “do something fun.” A gift.
For Christmas, the congregation decides to give Pastor Smith a new TV. Everyone knows he wouldn’t spend that kind of money on himself. Giving tax-free gifts to the minister could be interpreted as “inurement” and should be avoided to maintain the church’s non-profit status. In most circumstances, gifts from the church are treated and reported as taxable wages.
Occasionally Pastor Smith preaches at other churches, perhaps during revival or when their minister is on vacation. Often Pastor Smith receives a love offering for his services. Careful, the IRS also appreciates the effort. Since Pastor Smith is not an employee of Riverside Church, the IRS puts this offering in the same bucket as other self-employment income.
Regardless of whether a minister performs ministerial services as an employee or a self-employed person, earnings, including wages, offerings, and fees, are subject to income tax. Further, expenses are also handled differently with income earned as an employee or as a self-employed person. IRS.gov
Exemptions from Social Security and Medicare taxes are irrevocable
Exemptions can be granted for ministers and certain other religious workers and members of certain recognized religious sects. For details, click here.
Clergy members and Superman need tax specialists
The IRS considers ministers to be employees of their churches for federal income tax purposes and self-employed for Social Security and Medicare purposes. Any payment for services performed outside of ministerial services duties, as defined in the minister’s job description and covered under the W-2 wages, are considered taxable self-employment income.
As an example, consider:
Pastor Smith also performs and receives compensation for non-ministerial yard services. Clark Kent also performs unexpected super-hero services. Both work under two different tax systems. Pastor Smith is an employee of Hilltop Church. Clark Kent is an employee of The Daily Planet.
Pastor Smith and Clark Kent have side gigs. When Pete Smith mows grass and Superman flies through the air wearing tights and a cape, they must report compensation to the IRS as self-employment income.
Superman’s tax situation is unusual. Perry White, Clark Kent’s boss, said, “I want the name of this flying whatchamacallit to go with the Daily Planet like bacon and eggs, franks and beans, death and taxes, politics and corruption.” Kent said, “I don’t think he would lend himself to any cheap promotion schemes though Mr. White.” More about Superman
The bottom line
Pastors and ministers focus on other people and their own names often drop to the bottom of their to-do list. Tax laws are not top priorities, and it’s often early-April before a calendar notation pops up on their must-do list. Being in this reactive rather than proactive tax position is both expensive and distracting.
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